Introduction

Is money, or the love of money, the root of all evil? Should we eliminate money? If we eliminate money, will all evil disappear? If the answer is no (it is), then money must not be the root of all evil. If we eliminate money, what economic consequences will this have? What are the functions of money? These questions, among others, are answered in this unit.

Nearly every country or region in the world has a central bank. The most important roles of a central bank are to supervise a nation’s banking system and to control its money supply. Sections 3 and 4 discuss the role of the central banks and the Federal Reserve (the Fed) System in the United States. The Federal Reserve Board is in charge of the monetary policy in the United States. Its aim is to act independently from Congress and the White House. United States citizens do not elect Federal Reserve Board governors. They are appointed by the President, and then approved by the Senate. The disadvantage is that the Fed governors are not directly accountable to the voters. The advantage is, however, that unlike politicians, Federal Reserve Board governors can act regardless of what may be the popular thing to do. They can, therefore, concentrate on long-run policies (they don’t always do this though).

The Federal Open Market Committee is the day-to-day decision-making committee of the Federal Reserve System. Financial markets around the world closely follow every step the FOMC makes. In addition to controlling the money supply, it serves many other functions, which are explained in this unit. During the two decades preceding the 2008/2009 economic crisis, consumer price inflation in the United States remained relatively low. However, housing prices rose significantly, in great part due to Federal Reserve injections of money into the economy. This led to much irresponsible borrowing, created a housing price bubble and led to the housing crisis and Great Recession of 2008/2009. After the crash, the Federal Reserve significantly increased the money supply and even started buying Mortgage Backed Securities (in addition to government securities). Consumer price inflation has been low since the recession, in part due to relatively low growth. However, asset price inflation (prices of houses, stocks, and other investments) has been high again (just like before the crash). This may lead to another bubble that bursts. In addition, once the speed of the economic recovery picks up, the recent large money injections may translate into higher consumer price inflation.

Fractional reserve banking, the Federal Deposit Insurance Corporation, velocity and the quantity theory of money are discussed in the last sections of this unit.